Macroeconomics and Social Policy

The project on Social Policy in a Development Context elaborates the core principles underpinning social policy as the edification of a state-society nexus that is developmental (facilitates and promotes economic growth and structural transformation), democratic (derives its legitimacy through popular participation and electoral process) and socially inclusive (pursues social policies that provide equitable entitlements for all citizens to ensure that their capacities and functionings are adequate for a decent inclusion in societal affairs). The project includes several thematic and region-centred comparative projects (see Social Policy in a Development Context link, under “Related Information”). This thematic project on Macroeconomics and Social Policy explores some of the key aspects of pro-poor macroeconomics. The research for this project is being externally co-ordinated by Giovanni Andrea Cornia.

During the last two decades, despite continual improvement, progress in most aggregate indicators of human well-being slowed down, was limited to fewer sectors and were more unequally distributed. This situation poses policy makers and researchers with two broad challenges. The first is concerned with social policies that improve well-being while at the same time promote economic growth. The second focuses on economic policies that lead simultaneously to growth and social progress—pro-poor macroeconomics. This project takes up the second challenge.

In tackling such questions, this project will pay special attention to two important new characteristics of macroeconomics that have emerged in the last two decades. The first is the growing instability of the global financial economy, which is associated with an increase in numbers of financial crises, greater volatility of growth and an asymmetric distribution of the benefits and costs of financial globalization. The second involves a loss of domestic policy making capacity in an open economy, which poses policy makers with serious dilemmas when dealing with problems of e.g. increasing poverty and inequality. Given these challenges and constraints, what are the policy instruments that can be adopted for pro-poor macroeconomics?

In an increasingly unstable world economy, the first task of pro-poor macroeconomics is to adopt policies that reduce volatility and the risk of macroeconomic shocks. This project will tackle the following issues:

● Controlling and harnessing the capital inflows, e.g. through proper sequencing of capital account liberalization, an increase in regulatory capacity of governments, or the introduction of capital controls across or within national boundaries;
● Establishing and choosing the ideal features of a pro-poor exchange rate regime, which may leave developing countries less vulnerable to shocks emanating from the world economy;
● Establishing a global insurance mechanism, which should be set up before an explosion of global crises. This should come into play when shocks originate from the global economy

Once a country has been hit by a shock, stabilization is necessary and beneficial, including for the poor. By exploring the issues below, the project will seek to devise pro-poor macroeconomics, which pursue stabilization in ways that are protective of growth and the poor.

● The distributive and poverty effects of devaluation-based vs. monetary/fiscal-based stabilization in different archetypes of developing countries. The former generally maintains employment, while reducing real wages for all and the latter tends to affect employment prospects for some. However, different types of economies have different optimal solutions, depending e.g. on the size of foreign debt and the price elasticity of exports.
● The optimal choice of stabilization targets and the pace of adjustment. The two most common adjustment targets are to reduce inflation and the budget deficit. When these are pursued with excessive prudence, key investments in e.g. infrastructure and human capital risk being forgone. This is especially true for temporary deficits, which have no appreciable effects on macroeconomic performance. Pro-poor macroeconomics must also take into consideration the higher social discount rate of the poor, which entails they generally prefer a slower adjustment pace even if this implies a higher overall output loss.
● The nature of (permanent and temporary) domestic safety nets compatible with the new macroeconomic characteristics. Economic and social rationality demands that pro-poor and efficient public spending is preserved, or even accelerated, during crisis situations. In the budget process, such objectives can be promoted by ‘earmarking’ revenue to a few essential programmes or by establishing by law transparent public expenditure priorities. This project should explore the conditions and political coalitions that facilitated the adoption of efficient expenditure cuts and reallocations in some countries but not in others.
● Debt relief, fiscal flexibility and public deficit. Countries hit by external shocks or facing enduring crises often try to reduce the public deficit, by freezing, reducing or cancelling part of the debt. This project should explore the fiscal benefits and impacts on the poor of these different approaches, as well as explore alternatives such as automatic and costless ‘debt standstills’ and fiscal flexibility.

For the project to arrive at answers to the issues above, various papers have been commissioned including theoretical analyses, a review of the pertinent literature, regression analyses and structured comparisons of country experiences.